Barriers to Digital Import-Export Trade: Data Localization ARTICLE

By Zack Andresen

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As the digital economy continues to experience meteoric growth around the globe, businesses of all sizes have unlocked new global cross-border trade opportunities with unprecedented potential to upend the way both B2C and B2B customers purchase goods. But this is particularly true for small- and medium-sized enterprises (SMEs), which the International Chamber of Commerce (ICC) reports are five times more likely to engage in import-export trade when using online e-commerce.1

But before businesses can realize the full potential of global e-commerce, a number of digital import-export trade barriers must be overcome, according to the ICC report. Perhaps most notable among the various governmental policies and logistical hurdles currently challenging cross-border digital trade is the roadblock known as data localization.2

The post discusses why countries impose data localization and how it may impede SME penetration of global cross-border trade.

What is Data Localization?

Alongside the rise of the digital economy comes user data offering unparalleled insight into consumer buying behaviors that hold innate value for companies looking to diversify their business internationally. Businesses armed with user data for a given country or municipality could build entirely new business models around the demands of those local consumers.3 As such, a company operating in the U.S. can theoretically access and interpret local data for customers in India, and based on their findings develop personalized product offerings suitable for consumers in that local market.4

However, recent trends point to more countries barring the export of local data through a series of laws and mandates that act as a barrier to cross-border trade.5 Commonly known as “data localization,” these provisions require user data from the internet be kept in storage centers physically located in the data’s country of origin.6

According to a May 2017 report from the Information Technology and Innovation Foundation (ITIF), 34 countries have enacted or proposed data localization restrictions at a significant cost to their own and global GPD.7 Most notable of late are Russia and China, both of whom have enacted data localization measures in the last two years with potential to impact on future import-export trade.8

China’s latest cybersecurity law went into effect on June 1, 2017, and as analysts sort out the details, global companies have become increasingly wary of its implications for conducting business with the world’s second largest economy.9,10 Likewise, Russia’s limitations on the flow of cross-border data has already impacted on U.S. companies.11 Perhaps most notable was Russia’s November 2016 move to completely block LinkedIn, after the professional networking site refused to keep data on its six million Russian users in local data storage facilities.12

In the European Union, several countries - including Germany13 and France14 - have imposed data localization measures. In a November 2016 speech, European Commissioner for Digital Single Market and Vice President of the European Commission Andrus Ansip noted that if all existing data localization laws within the EU were revoked, it could generate an additional €8 billion per year in EU GDP.15

Measures such as these are causing increasing concern among analysts that although digital e-commerce holds the potential to scale the global economy to an unprecedented degree, data localization and similar digital trade barriers may impede that growth.16

Why Do Countries Continue to Impose Forced Data Localization Laws?

While each country outlines its own reasoning for enforcing data localization, the general consensus among government leaders who enact such laws is that doing so protects the country’s citizens from a number of threats.17 Those perceived threats run the gamut from cybersecurity and terrorism (as was the case for China’s new law), to the belief that data localization strengthens the local economy by warding off external global competitors.18,19

In theory, data localization laws could boost local economies by forcing global companies to open offices - or at least, data centers - in the country. In turn, that could mean more jobs and further economic development.20

Another motivating factor behind enacting such laws is the protection of citizen privacy. This holds particularly true in the EU, where a Data Protection Directive restricts the transfer of user data outside the EU to a shortlist of 12 countries, including the U.S., whose data security measures meet defined EU standards.21,22

While the intention of data localization is in most cases well-intentioned, the general consensus among analysts is that such laws actually do more harm than good for a country’s citizens.23 That’s largely a result of the platform on which the digital economy is built: the internet. By design, the internet is an open, borderless network and therefore requires the free flow of information to flourish.24

As such, the restriction of data tends to have an opposite effect than desired: rather than stimulate growth, data localization actually discourages it by imposing restrictive cost hikes on companies that might otherwise engage via import-export trade opportunities.25

Perhaps no segment feels that impact more directly than SMEs, whose ability to fully capitalize on cross-border trade opportunities suffers as a result of data localization.26

How Does Data Localization Impede SMEs’ Cross-Border Trade?

First, at the local level. Businesses operating in countries with restrictive policies face the rising costs of a classic “supply and demand” dilemma when buying storage in local data centers, because such rules artificially restrict potential market suppliers. For many SMEs, the price tag to store data locally is too high to create a viable business plan. As a result, startups operating in countries with data localization policies often struggle to generate funding from venture firms as the cost of business operations is often viewed as a major detriment to long-term scalability.27

The second way data localization blocks SMEs from fully diving into the world of global import-export trade is through the increased cost of developing market intelligence. Without access to local user data, international businesses have difficulty scaling their solutions into new markets where valuable customer data would have historically driven their business plan.28

The Takeaway

While SMEs’ emergence in the digital economy is an exciting prospect, there are still some critical barriers to import-export trade that need to be overcome before digital trade’s true potential can be fully realized. Data localization is one such barrier. While many have been vocal about the detrimental impact of forced localization, it’s not clear that a solution is on the horizon for companies interested in engaging in cross-border trade.

The Author

Zack Andresen

Zack Andresen is a business technology writer based in Brooklyn, NY, whose work has focused primarily on Software-as-a-Service (SaaS) technology.

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